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Liquidation Value: Assets for sale?

The first question we need to ask about the value of a company's assets is whether the industry of which the firm is a part is economically sustainable. If the industry has no future, then neither does the firm, at least in its present form. In that case, the income will shrink and drag down the value of those assets that cannot be transferred, particularly specialized equipment and intangibles such as organizational capital and customer relationships.( I call these dying companies) If the industry is thriving, even a failing firm may sell transferable as sets for decent prices to more successful companies in the industry. (Buy-outs)

When the company's own profitability has plummeted, when it faces financial duress in the form of one or another of the chapters of the bankruptcy code, and when the industry looks feeble, then the firm may be worth no more than the liquidation value of the assets. Table 4.1 presents the balance sheet for a fictional company that appears to be either on the rocks or floundering a few yards away.

Between 1997 and 1998, the company's retained earnings fell by almost $4,000, putting its net worth below zero. (What are retained earnings: Perhaps this was a temporary setback and the firm will be able to convince its lenders to extend it more money to meet its interest obligations. We can't tell from this fragment of information, and we really don't care. All we want to be able to do is estimate the value of the assets if the firm is to be liquidated (see Table 4.2).

In the Red FA Charlie Mar

For cash and marketable securities, there should be no discount from the amount stated on the company's books, provided that the securities are short-term or have been marked to the market. Accounts receivable will probably not be recovered in full, but since it is trade debt and there are plenty of specialists who know how to collect it, we estimate that we can realize 85% of the stated amount. What the inventory will bring depends on what it is. For a manufacturing firm, the more commodity-like the inventory, the less the discount necessary to sell it. It is those tie-dyed T-shirts that have to be marked down, not the cotton yarn. If, on the other hand, the inventory consists of cartons of last year's unsalable toys, then it may be necessary to pay someone to cart it away. We estimate in this case that we can realize 50% on the inventory; if the inventory is highly specialized, then the valuation would have to be substantially lower. In those situations in which the value of the inventory is critical to the over-all valuation, an expert appraiser can be called in to determine a value that is more precise than the back-of-the-envelope estimate.

The same holds true for property, plant, and equipment. Detailed knowledge of the real estate and the equipment is necessary to come up with an accurate estimate. Certain broad principles apply. Generic assets such as office buildings will be worth far more, relative to their book value, than will specialized structures such as chemical plants. We have put down 45% as another quick and dirty valuation; if this entry is critical, we can hire another expert to do the appraisal. We ascribe no value to the goodwill; it merely represents the excess over fair market value that the firm paid in making those acquisitions that may have gotten it in trouble! Deferred tax assets, the refunds the company can expect over time from the IRS, are offset against deferred taxes owed. Putting all these figures together, we come up with a value of $2,756 for current assets and $3,375 for property, plant, and equipment, for a total of slightly more than $6,000. Who might want to invest in this company's securities? Certainly not a traditional equity purchaser, no matter how value-oriented. But there is room for gain here, provided one is a specialist in buying up distressed debt. Though it looks fairly certain that if the company is liquidated there will not be enough money left to pay anything to owners of either common or preferred shares, there probably will be funds for the owners of the debt. Accounts payable and accrued expenses amount to only $2,667, even if they receive dollar for dollar. Everything else can flow to the holders of the debt. Debt on the books comes to $12,220, but given the condition of the company, the bonds would certainly have been available for substantially less. If the discount is steep enough, and there is enough value in the property, plant, and equipment, this might be a lucrative opportunity for an expert in distressed debt securities and liquidation values.

In theory, the accounting entry for goodwill represents the cost of acquiring intangible assets like product, customers, and market positions that are "real" but are not

represented on the balance sheet of the company being acquired. The natural way to

proceed in putting a value on goodwill is to identify the tangible measures- product

lines, numbers of customers, trained workers, or the accessible population--under-

lying the accounting entry and to value each of them separately. But for a company in

a nonviable industry, these highly specialized assets are not likely to have any significant value. Thus, our bottom line for goodwill is zero.

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